The Bank for International Settlements (BIS) notes that more than three quarters of global interdealer FX turnover was controlled by just six banks in 2016 compared to 14 in 1998, although it also acknowledges that most of that concentration happened prior to 2008.
The banks that are dominant now were among the first to embrace technology and as a result have built global franchises with embedded risk management, price discovery and execution tools that enable them to manage client flow effectively and cater to a wide range of trading strategies and order types, observes ParFX chief operating officer, Roger Rutherford.
“Providing that level of service requires a substantial investment in technology, connectivity and market data and only a handful of banks have the scale to achieve this,” he says. “We are also seeing increasing levels of regional or product specialization amongst smaller and mid-sized banks.”
Brad Bailey, a research director with Celent's capital markets division, refers to the increased concentration of major dealing banks in key currency pairs over the last decade. However, he also notes that these banks are the major suppliers of FX liquidity globally, much of which is being leveraged in innovative ways – for example, resold through a variety of white label solutions, partnerships and alternative liquidity provision.
PointFX CEO, Henry Wilkes, says concentration of primary liquidity within a few large market makers is an issue, with the bulk of the interbank market reduced to a secondary role of providing their customer base with recycled primary liquidity.
However, he also reckons there are signs that the industry is adapting to the new structure and that the gap in primary liquidity providers is being filled by non-bank providers and platforms that are allowing increased access to buy-side flow.
'Sign of competition'
The BIS committee also reported that the proportion of spot FX trading conducted on Thomson Reuters Matching and EBS Spot has fallen by two-thirds over the last decade. However, Andy Woolmer, CEO of NCFX, suggests that rather than viewing this as market fragmentation, it is a sign of increased competitiveness.
“Reuters and EBS once possessed a quasi-monopoly in the inter-dealer FX market where EUR/USD volume was concentrated on EBS and Reuters had a niche in GBP/USD,” he explains. “This concentration of market activity was a legacy of a two-tiered market, of privileged dealers able to trade on prices that were not available to anyone else and clients (not dealer banks) obliged to trade on one way pricing.”
The key question to ask is whether clients are better off in terms of their ability to trade for a reasonable cost, with a reasonable level of certainty of execution within an acceptable timeframe, adds Woolmer.
“Costs have come down and the evidence suggests the dispersion of pricing has increased – a sign that the market is becoming more competitive,” he continues. “Another sign of increasing competition is the decrease in internalization rates among the top dealing banks. As banks capture a smaller percentage of market share they are less able to exploit network benefits, of which internalization is one.”
FX markets are simply returning to their roots, where liquidity providers provide a risk transference service to real FX clients and have the technology and risk management capabilities to either internalize the flow or trade out of it bilaterally, suggests Integral chief revenue officer, Vikas Srivastava. “This OTC market structure is simply more economically efficient than central limit order books and the data has begun to show it,” he adds.
There has also been a rise in co-location, which has lowered connectivity costs between participants and contributed to an increase in relationship-based trading and therefore the ability for participants to internalize.
“While this has led to a reduced proportion of central limit order book trading activity, the major CLOBs remain important for several inelastic reasons: a central point of price discovery – which is a cornerstone of dealer to customer pricing – and firm/deep liquidity, which is critical during volatile trading periods,” says Jeff Roberts, business manager at NEX Markets.
The fact that the spot FX market has a number of venues where orders can be executed means there is stiff competition among those venues to increase their market share, notes Pragma Securities chief business officer, Curtis Pfeiffer.
“In order to do so, they have to provide better execution quality, which benefits the trader,” he concludes. “So, as long as the trader has high quality trading tools – such as execution algorithms – fragmentation can benefit their execution quality.”